A Reefer Recession?
The forces behind Michigan’s plummeting cannabis prices
December 12, 2022
Crain’s Detroit Business
By: Dustin Walsh
Glacial Farms, a medium-sized marijuana grow operation in the middle of cornfield country between Jackson and Ann Arbor in the village of Manchester, is in a battle — against viscous market forces and unrelenting competition.
Product oversupply has collapsed marijuana prices from $494.77 per ounce of flower in February 2020 to just $102.65 per ounce in October this year.
Simply put, there’s too much weed being grown and not enough places to sell it and not enough consumers, potentially, to consume it.
The result is a market freefall.
The Michigan Cannabis Regulatory Agency is cracking down on illicit market marijuana making its way into the regulated market — some retailers and growers are cheating the system by selling unregulated marijuana, avoiding testing requirements, labor and fees, to boost margins.
The big operations are vertically integrating, buying up distressed retailers to ship product direct and enjoy the shrinking margins on both sides of the grow retail coin.
Glacial Farms, which currently operates a sole 15,000-square-foot grow facility and sells weed wholesale under the Glacier Cannabis brand, is looking for additional grow space to simply maintain its current margins. The company is nearing a deal to lease an additional 8,000 square feet of grow space.
“Competition is fierce,” said Andrew Sereno, CEO of Glacial Farms. “Right now, it comes down to how strong your brand is and whether your product is in demand. We’re seeing the market collapse on itself a little. There are cultivators and processors already falling offline. The writing is on the wall. You either need to be efficient or get out.”
The Michigan Cannabis Manufacturers Association, which represents some of the largest growers and retailers in the state, is pushing for a temporary license moratorium, eliminating new entrants into the market to stymie supply and raise prices. That move would require a three-quarters vote in the Legislature.
But a weed recession is on the horizon and whether the free market or policy interventions can stop it is unknown.
“People were coming in and built business upon the fact that marijuana was $2,500 a pound,” said Doug Mains, a partner at Detroit law firm Honigman LLP and co-writer of the original adult-use recreation ballot language. “Now it’s down to $500 and they are hemorrhaging, wondering what happened. But this is how the market was set up here. There was going to be competition and that’s what we’re seeing play out. You either have to survive low prices or have better product than your competitors.”
Grow to Survive
Sereno expects the bolt on leased space to double its grow operation — the 8,000 square feet is two-tiered, effectively making it 16,000 square feet of grow space. But the additional overhead isn’t going to result in twice the revenue. Sereno said the addition will improve revenue from $5 million this year to $7.5 million in 2023 and will do almost nothing for its profits.
“We’re only doing this to maintain our profits,” he said. “It’s a low capital expenditure because it’s already built out and we can use our existing team to leverage the administrative and labor costs.”
Glacial Farms is taking over for a defunct grower, one that couldn’t make the math work with depressed prices.
Jonathan Kirkland, an attorney for Detroit law firm Butzel Long, said the industry is forecasting a recession that may spur mass consolidation that pushes out smaller operators.
“There’s already consolidation in the space, we’re seeing lots of M&A (mergers and acquisitions),” Kirkland said. “The next one to five years will be challenging for mom-and-pop growers, provisioning centers and adult-use retailers. Some will go out of business and others will be bought out by larger operators.”
Andrew Livingston, director of economics and research for Denver-based cannabis law firm Vicente Sederberg LLP, said the ease in which cultivators could get licenses in the early days of legalization has led to this “musical chairs” moment in the market. Effectively, independent growers are being pushed out by the retail consolidation of vertically integrated operations.
“There are more independent cultivators than independent retailers,” Livingston said. “The vertically integrated companies come to the dance with their own date or multiple dates. This puts the squeeze on the independent cultivators, leaving them to have to find the limited independent retailers who are already being bought up by the vertically integrated companies. There’s simply not enough chairs and cultivators are fighting for the last chair by dropping prices to make sure their products get to market and so everyone lowers prices, making the problem even worse.”
One of the largest operators in the state, Marshall-based Common Citizen, is seizing that consolidation opportunity from those low prices.
“Vertical integration is the key to … surviving,” said Mike Elias, president and CEO. “We knew there would be a day of reckoning, so as everybody is selling, we’re buying. We started our company as predominantly a provider of wholesale product with a lot of manufacturing capability. We wanted reach, for our brands to get exposure. … Now to hedge against the price decline, it’s time to go vertical. The advantage is instead of selling wholesale for $2,000 a pound, I can sell it for $4,000 a pound in the retail space and enjoy the whole of the margins on both sides. The way to secure your market share it to get more retail and maintain a chokehold on the wholesale market.”
Common Citizen is considering selling its Battle Creek and Flint dispensary locations but, in July, it acquired LIV Cannabis, a retailer in Ferndale. Common Citizen is “stamping and repeating” the LIV stores in other locations, such as Lapeer and Buchanan.
“Everyone is calling me to sell,” Elias said. “It’s perfect. It’s exactly what our business model was designed to do. We’re blessed to have a lot of backing from wonderful investors who want to put their capital to work today. Distress in the market is a great opportunity to get these entities at a discount.”
Tangled up in Weed
Common Citizen distributes its product from a 200,000-square-foot grow operation in Marshall. But it’s utilizing only one-sixth of its license capacity to grow plants.
The state issues different grow licenses with differing caps on the number of plants that may be grown at one location. A Class C grower license allows for 2,000 marijuana plants per location and they can be “stacked” for up to five licenses per location or a maximum of 10,000 plants.
It’s likely Common Citizen will look to boost how much it grows to feed into its current retail operations and future acquisitions.
Glacial Farms’ doubling of its grow operations also means more marijuana on the market. Glacial is now selling wholesale packaged products by the ounce containing a chillum (a small pipe for smoking) called a “Snowpack” to boost margins.
“We can pass different discounts through at a higher volume,” Sereno said. “Maybe someone has $20 burning a hole in their pocket, but what if they have $100? We can capture that person and move more product at a better margin.”
All of this posturing to enhance market share and margins likely leads to more marijuana being grown and exacerbates the oversupply problem that has collapsed prices.
“Operators are trying to reduce their variable costs by getting bigger,” Livingston said. “The only way to stay in business is to increase your size, allowing you to drop your wholesale costs and put more product onto the market, which dampens prices even more. Controlling that price spiral is difficult.”
Distilling a Solution
The industry has, for the past year or so, tried to sidestep the oversupply issue by pointing to illegal marijuana making it into the legal market.
The theory is that mass amounts of distillate, used in making vapes and edibles, is being shipped in from out of state at a steep discount and finding its way to store shelves. The other gripe is that marijuana grown by individuals is finding its way into retailers and growers without being entered into the state’s tracking system.
There’s evidence this could be true.
The number of active marijuana plants being grown in the licensed market grew 120 percent between August 2021 and August 2022, just above sales growth of 103 percent. Yet licensed market inventory, by pounds, grew more than 400 percent during the same 12 months.
That’s a major discrepancy between plants coming online and the inventory on shelves.
Industry pressure on the CRA to take enforcement more seriously led CRA founding executive director Andrew Brisbo to resign from the post this year. He was quickly replaced by a Michigan State Police crime analyst favored by the industry.
Director Brian Hanna has made it clear he plans to clean up the market.